Student Loan – The Cause of next Financial Crisis?

Is student Loan really the cause of next financial crisis

The question might seem a little absurd, but it’s worth taking a look. It is reported that over $120 Billion in Federal Student Loans is in default and thus it can be the reason for the next financial crisis globally.

One question that has always evaded greater scrutiny has been the very critical default rate for student borrowers, a number which very few lenders and colleges openly disclose for fears that the general public would comprehend not only the true extent of the student loan bubble, but that it has now burst. Based on the data released, the default rates for federal loan borrowers was rising but was not too troubling. Upon investigation, it was found that the reason on why the risk was still low despite increasing the defaulters was due to the use of fudged data that drastically misrepresented the seriousness of the situation thus dramatically undercutting the amount of bad debt in the system.

The United States Department of Education, for the first time ever, released official three-year or much more thorough federal student loan cohort default rates. Unexpectedly the numbers turned out to be surprising, though in a negative sense. The number, for all colleges, stood at a stunning 13.4% for the 2009 cohort. The number reported is shocking as it is nearly 50% greater than the old benchmark, which tracked a two-year default cohort, and was a “mere” 8.8% for the 2009 year thus clearly explaining about the seriousness of the situation of rising debt.

The new improved report which is broken down by type of education and uses a much more realistic benchmark, for-profit institutions had the highest average three-year default rates at 22.7 percent, with public institutions following at 11 percent and private non-profit institutions at 7.5 percent.

Thus, in other words, it can be said that more than one in five federal student loans, or loans for unemployed is now in default and will likely never be repaid!

Also, it is next to impossible to use historical data to extrapolate with precision the current consolidated federal student loan default rate though we do know that there is $914 billion in federal student loans (which also was mysteriously revised over 50% higher by the Fed). It is reported that there is now at least $122 billion in federal student loan defaults and surging every day.

The picture is crystal clear on why the Federal administration has been so reticent about disclosing the true state of the Federally-funded student loan bubble. Because if one simply assumes the rising default rate has kept constant across all recent cohorts since the updated 2009 number, it would mean broadly speaking, that of the $914 billion in Federal Student Loans at least 13.4% will end up in default.

Will it be right to say that we are about to meet the new subprime?

Well, the answer to that was quietly reported in the recent news stating that the new data released by Department of Education indicated there had been a concerted push by all sides to misrepresent the severity of the student debt problem, by over 50%. Thankfully the “why” in the case need not be answered and is quite simple. Thanks to the US president Mr. Barack Obama, who touted an executive order easing the process of applying for a loan program by the unemployed that lets students make lower payments tied to their income? This results in easing their burden and making it less likely they will default. Under the new 3-year measure, colleges with default rates of 30 percent or more for three consecutive years will risk losing eligibility for federal financial aid. The same is applied in case of schools as well as the rate balloon fixed at 40% in a single year.

It was also found in a report by the Senate Committee that some of the for-profit colleges encourage students to defer payments in their early years, in an effort to keep down default rates which could help them jeopardize their federal funding. The report accused for-profits of using the tactic to manipulate their default rates.

Federally funded student loans are now increasing at a rate of over $60 billion per quarter which estimates that in about 18 months the total size of the Federal student loan will touch the whopping $1.3 trillion mark. Is the number surprising? Well, that’s the number of the last subprime crisis resulted due to mortgage loans. $1.3 trillion was the reported size of the subprime market when the credit bubble busted. Thus it can be seen that the Federal student loan bubble has not only popped but has all the carbon copy makings of the next subprime crisis and this time it will be something bigger than compared to mortgage subprime crisis of 2007. The reason is simple, mortgage crisis had properties left behind whereas in case of student loan no recoverable asset is present as the asset himself is a human being. Thus a simple mantra, its time we need to act to save the global economy from a new phase of recession which is going to hit soon with greater power and a greater loss to life and humanity.

Niraj Satnalika

Niraj is an MBA in International Business (Finance). Prior to this he completed B.Tech in Electronics and Instrumentation. He is currently working with Confederation of Indian Industry (CII), Kolkata in capacity of Consultant.
Satnalika is actively involved with an NGO and works towards promoting education among the underprivileged.